Corporate Governance in Mexico
Mexico was a land inhabited by various indigenous civilizations (i.e., Mayas, Aztecs). It was conquered by the Spanish captain Hernán Cortes in 1521. The country today is a blend of its history; 80 percent of its population is a racial mix between the Spanish and the native cultures. It is mostly a collectivist culture that is socially cohesive. It is, thus, a traditionalist society where family, religion, and culture play a key role.
The legal system is based in civil law as for most former colonial members of the Spanish empire. The role of the marketplace is constrained by the government and local interest groups such as unions, political parties, commerce chambers, and private firms. Because of this, the market for corporate control is weak and almost nonexistent. Corporate governance codes are voluntary, although they are being slowly incorporated into securities laws.
Corporate ownership in most firms is concentrated and institutional investors—even though present—are still not major players in the market for corporate control. Minority ownership is protected for the standard of an emerging economy. Shareholder activism is uncommon. Corporate boards are single tier in nature, and it is common to have CEO duality where the CEO is also chairman of the board. Corporate boards are made mostly of insiders and representatives of the controlling shareholders. Independent board members have grown in importance, but they still do not hold majority stakes for most firms.
The Mexican Stock Exchange formally opened in 1895. In 1905, it was quoting around 60 mining firms, 30 industrial firms, and 20 banks. Modern stock trading did not begin until 1933 through the creation of the CNBV—National Banking and Stock Market Commission—which would serve as its main regulatory body. Until the mid-1970s the stock market did not represent an important source of financing for firms (most financing was provided by banks and state-owned financial institutions) but, in 1975 a new stock market law that fostered the institutionalization of brokerage firms emerged. This law along with the oil market boom that lasted until 1979 multiplied the stock market index by six. Then came a crash and the economy encountered additional problems that ended with the nationalization of banks in 1982. Probably as a result of these shortcomings, market capitalization of the stock market went from 10 percent of GDP in 1978 to 1 percent in 1982. It then fluctuated from 1 to 2 percent of GDP until 1987 (Bebczuk et al. 2007).
In 1985, Mexico joined the General Agreement on Tariffs and Trade (GATT). In 1993 it signed NAFTA with Canada and the United States. Along with the liberalization of trade, the government implemented a far-reaching fiscal reform. Most state-owned firms were privatized, and their number decreased from 1,155 in 1982 to 220 in 1993. Income tax was reduced from 42 to 34 percent and tax compliance was enforced. Government subsidies were notably decreased. These reforms helped in changing the primary fiscal balance from negative (1970 to 1982) to positive (1983 to 1993).
Corporate Law
There are two basic laws that deal with firm corporate governance. One is the Law of Mercantile Societies (1934) dealing with the creation of a limited liability firm—sociedad anónima. It establishes investor’s property rights and the regulation of different monitoring and counseling bodies of the firm, such as the board of directors, stockholder’s assembly, auditor, and a commissioner. This law applies to all private firms in the country. The second one is from 2005 and applies to firms listed in the stock exchange. It is the Law of Securities Markets. When the 2005 edition of this law was approved, it had two objectives that distinguished it from its 2001 version: one, to promote the introduction of new firms to public markets by simplifying regulations and making mid-size firms more attractive to venture capital; and two, to improve transparency, minority rights, and corporate structure of listed firms. Private firms are obliged to follow the 1934 law where the board of directors is mostly responsible for operating a firm. The traditional monitoring role of a board in the 1934 law corresponds to a statutory auditor that reports directly to the shareholder assembly. Many private firms have voluntarily instituted practices from the Law of Securities Markets but they still need to comply with the Law of Mercantile Societies from 1934. The updated 2005 version of the law for securities markets emphasizes a proper identification of controversial matters and excess risks, compliance with norms related to audit matters, and the vigilance of mechanisms that promote transparency. An important issue is the creation of the audit and corporate practice committees that must be wholly formed by outsiders with three members each. The corporate practices committee has a say on transactions with related parties and reviews TMT compensation policies including loans and nonmonetary compensation. It also convenes all shareholders assemblies.
The external auditor figure must inform the Mexican Securities and Exchange Commission (CNBV) of any issue that threatens corporate stability. External auditors must meet a specific set of personal and professional requirements. They are now liable for any harm caused to firms by their misreporting. The CEO—Director General—is responsible for implementing all agreements made in the shareholders’ assembly and must set guidelines for control and audit procedures. It is now also mandatory for the CEO to rubricate financial statements as well as any relevant economic and legal information.
Top managers and board members now have a duty of loyalty to the firm. Thus, its members must act in good faith instituting shareholder value maximization policies. A breach to the duty of loyalty will occur with a conflict of interest whereby a group of executives or shareholders is benefited at the expense of others. Another possible breach of loyalty could occur if inadequate transactions are approved.
The board of directors in the new law is a one-tier board appointed by the shareholders with a maximum of 21 members. There is a possibility to designate proprietary and substitute board members. Proprietary members are the “owners” of the board seat notwithstanding their share of the firm capital. Proprietary members designate their substitutes subject to board approval. Public boards should have a minimum of 25 percent independent members. They require at least one audit and corporate practice committee wholly made of independent members. There should be a minimum of four meetings per year. Minority shareholders representing 25 percent of capital can designate at least one board member if the board is made of at least three members. If the firm is public, the ownership stake is decreased to 10 percent. In its annual meeting, shareholders must define policies for the use of firm assets, board member nominations, and internal audit systems. Boards oversee strategy and internal control procedures, supervise top management, approve financial statements, set top management compensation packages, and authorize relevant/related transactions. Likewise, this new law helped improve compliance with audit procedures and prevent conflict of interests by mandating that CEOs rubricate financial statements as well as any other relevant economic and legal information.
Half of the board members should be present in each meeting to have legal quorum. Each board member has one vote. The law allows boards to take decisions without meeting, but this must be expressly allowed in each firm’s statutes, and there should be unanimous voting among board members on the issues. The chairman of the board has a “golden” vote in case of ties and does not represent the shareholders but the board itself.
A majority of the new governance reforms in the country are related to digitalization of processes, consolidation of procedures, and improvements resulting from the implementation of oral proceedings for commercial disputes. As a result, Mexico climbed four positions to the 57th place in the 2015 Global Competitiveness Index published by the World Economic Forum, mainly because of reforms in the areas of financial market development and business sophistication. The country has ranked above the average of Latin American countries in indicators such as Contract Enforceability, Minority Shareholders Rights Protection, and Access to Firm Credit.
The Code of Good Governance
The adoption of governance codes and committees has been a steady trend in the past two decades. As in other countries, crises partially triggered the code’s evolution.
First came the Mexican financial crisis of 1994. A lack of adequate mechanisms to regulate firm indebtedness as well as the supervision of loan portfolios from financial institutions contributed to worsening a vicious circle created by excessive risk exposure to foreign currencies by both firms and banks.
Then came the East Asian crisis of 1997 to 1998. A committee of Best Corporate Practices was created to pool resources from the private and public sectors. It was a multidisciplinary group that included academics, controlling shareholders, managers, and representatives of the finance, legal, and accounting professions. This was the first effort of its kind in Latin America, and one of the first in the world since it happened right before the US governance scandals of Enron and WorldCom. At that time, only the United Kingdom and a handful of countries had implemented similar efforts to foster transparency within financial markets.
As a result of this effort, in 1999 the committee published a code of best practices that included a series of recommendations of what was then considered best corporate governance practices. The philosophical principle underlying these codes is that disclosure of information on governance practices and investor protection allows markets to distinguish differences among firm policies. Ideally, this information should allow shareholders and potential investors to notice which firms adhere to investor protections, and consequently, those firms with better practices should be able to access capital at a lower cost because they are providing more environmental certainty. These fell into four main areas: i) information disclosure regarding administrative structure, objectives, and procedures of board committees, ii) existence of adequate channels for disclosure of financial information, iii) adequacy of communication between management and board members, and iv) protection of shareholder rights. All firms with public traded securities (debt and equity) need to disclose their information. Analysts and market participants can request specific information and constantly monitor the veracity of firm information. The reputation loss from untruthful answers could be significant due to this verification process by market participants. Information needs to be published as part of a firm’s annual report, which is usually approved by the board of directors. The code’s recommendations can be applied to governmental, nonprofit, small, or medium firms. Most other codes tend to focus only on medium and large publicly listed firms.
The code was revised in 2006 with an emphasis on board roles and a recommendation to issue ethics and social responsibility codes. In 2010, it was revised for a second time. Among its key recommendations are that board size should be from 3 to 15 members, with 25 percent of them being independent; the elimination of substitute board member figure; a reliance on outside support for audit, finance, planning, compensation practices, and policies; and finally, the supervision of: i) firms’ strategic vision, ii) CEO, TMT, and directors’ performance reviews, iii) protection of shareholder rights, iv) instituting information transparency and accuracy, v) the existence of internal control mechanisms and the approval of relevant/related transactions, vi) succession plans for CEO and TMTs, vii) contingency and information recovery plans, viii) assessment of compensation plans of CEOs prior to his/her entry, ix) instituting a policy for CEO and TMT compensation and termination packages, and finally, x) an adequate framework to analyze and review firm risks. The code was also updated in 2018 in order to include principles of fiduciary duty and risk. It also recommends to include the following policies: i) prevent and solve disagreements between directors and shareholders, ii) recruitment, hiring, evaluation, and compensation of directors, iii) designate family board representatives, iv) increase the proportion of female directors, v) ensure that the organization’s talent and structure are aligned to the strategic plan, vi) update ethics code as well as the unlawful act procedure/hotline, vii) the existence of an agreement within controlling shareholder families that delineates a procedure to designate their board representatives, viii) disclosure in the annual report of policies used for remuneration packages of CEO and top managers, ix) analysis of strategic risks, and x) disclosure of legal liabilities.
Laws regulating financial entities have recently included some of the codes’ recommendations. Namely, the size (3 to 15 members) and independent members (25 percent) plus other best practices such as i) shareholders with 10 percent of capital have the right to designate at least one board member; ii) boards should meet at least every three months with the presence of at least one of the independent board members; and finally iii) the existence of board audit and compliance—legal—committees.
Chong, Guillen, and Lopez de Silanes (2009) did an analysis of the 150 public firms in 2003 to 2004 and found that the mean company in Mexico met 78.4 percent of the code recommendations. The range of scores went from 30 to 98.2 percent. They additionally show how the number of recommendations met by the average public firm has increased over time; in 2000—the first year of the code, the average firm followed 64 percent of the principles, while the following year the number increased to 70 percent. There were smaller increases in 2002 to 2004, leaving the total compliance score at 77 percent. Both equity and debt issuers must comply with the code. Interestingly, compliance is higher among equity issuers; in 2004 they met 81 versus 65 percent of recommendations for debt issuers.
Alternative evidence of the code’s influence can be found in the 2013 editions of best governance practices of Mexican firms from Deloitte: 97 percent of the 394 public and private firms in its sample reported having a board of directors, practically unchanged from the 2009 data. Concurrently, 62 percent of those firms also have an Audit Committee (vs. 54 percent in 2010), and 35 percent reported the establishment of a Risk Policy Committee (vs. 27 percent in 2010). Mexican firms coming from industries such as auto manufacturing and energy have shown the highest rates of institutionalization for governance committees in recent years, a trend directly related to increased international competition and risk-management structures in these capital-intensive sectors (PricewaterhouseCoopers 2015).
The Equity Market
Market capitalization and the number of public firms in the Mexican stock market have not changed much over the years as we can see in Figures 4.1 and 4.2. However, the legal requirements and costs of doing an initial public offering (IPO) have changed for good. Firms aspiring to be listed must produce a prospectus complying with the rules of the Mexican Securities and Exchange Commission (i.e., Comisión Nacional Bancaria y de Valores: CNBV). The prospectus must largely comment on the intended use of newly raised funds and provide detailed information on the firm, its subsidiaries, and controlling shareholders. CNBV will verify the comprehensiveness of the prospectus and grant permission to trade after approving the document. Listed companies should comply with both listing and ongoing requirements.
Figure 4.1 Market capitalization (GDP) in Mexico
Figure 4.2 Number of public firms in Mexico (2000 to 2017)
The main listing requirements for an IPO company are: three years of operations history, a minimum stockholder’s equity value of US$6,321,138 (as of December 2018), positive net earnings for the past three years, a minimum free float of 15 percent of common stock and to issue at least 10,000,000 shares with 200 different shareholders, and a minimum stock price of US$0.3160. The requirement of three years of positive earnings means that small and young Mexican firms face large barriers to equity capital relative to similar firms in the United States or the United Kingdom.
Demand for equity shares in Mexico is limited by a lack of participation of institutional investors. The private pension system has legal restrictions on investments in equity markets (CONSAR 2017). According to the World Bank in its Doing Business 2015 report, shareholder right protection in Mexico is similar to that of OECD countries and higher than the Latin American average. A key reason for the limited supply of equity is the nature of its ownership structure; most firms are family owned and Mexico is one of the countries with the highest family ownership concentration globally (La Porta, Lopez de Silanes, and Shleifer 1998).
Among the reasons inhibiting new firm listing are: i) the stock exchange is perceived as a club of “big” firms, ii) revealing firm information can alert competitors, iii) going public might mean losing control, iv) the required changes to internal control and governance mechanisms are expensive and time consuming, v) revealing ownership details might be dangerous due to the prevalent sense of insecurity, vi) tax avoidance schemes that could be revealed, and finally vii) the loss of flexibility to compete against informal competitors.
Business Groups
Business groups are formed by legally independent firms that are bound together by formal and informal ties and are accustomed to taking coordinated action (Khanna and Rivkin 2001). Because government bureaucrats in emerging countries enjoy a great deal of discretion as to how regulations are enforced, groups may have the experience, size, and political connections to navigate in these environments (Khanna and Palepu 1999).
Coordination within business groups relies on a complex web of mechanisms like equity, debt, commercial ties, and relationships between top managers and board members. Business groups owe their predominance to market failures and poor-quality institutions (Granovetter 2005). According to Strachan (1979), business groups have three characteristics: i) diverse set of businesses in different industries; ii) pluralistic composition, meaning that groups are made of more than one family; and iii) a “fiduciary” ambiance where loyalty and trust associated with family values are present.
Groups typically pull resources and top managers from more than one family. They also tend to form either a bank or a financial institution in order to access capital from sources outside their own circle. They are also likely to have oligopolistic market power partially due to their political influence and overinvestment that preventively blocks new entrants and grants them growth spaces for future business.
The advantages of diversified business groups could decrease as stronger institutions are formed in developing countries and countries open their borders to foreign competition. Pointing in this direction, Guillen (2000) found that in situations where governments privilege specific entrepreneurs and restrict access to foreigners, business groups grow.
In a more detailed study, Khanna and Yafeh (2007) found that capital market under development is not a main driver of business group growth. Instead, it is other types of institutions like vague labor laws, low-skilled workers and managers, or the ambition to decrease taxes that are more important. There is also no clear correlation between greater diversification and profits.
Keiretsu in Japan and chaebols in South Korea are synonyms for “grupos” in Latin America. Grupos dominate a significant part of Latin American business, so understanding their characteristics is important for those competing in the region.
Business group development in Mexico is similar to that of other Latin American countries. Groups appeared in the early industrialization period of the late 19th century by creating large manufacturing entities that were stand-alone entities but were financed by banks owned by the same shareholders. They enjoyed a second growth period after 1930 where a network of firms was held together by holding companies. In the third growth period, business groups grew as part of the neoliberal restructuring that started in the 1980s (Del Hierro and Alarco Tosoni 2010). It is important to note that none of the large Mexican groups had a significant place in the high-technology sectors (Salas-Porras 2006b).
For the United States, Mexico and its “grupos” have become important for several reasons: a 2,000-mile border; a growing amount of trade, investments, and bilateral agreements; as well as the fact that there are 36 million Hispanics with a Mexican origin (Pew Research Center 2017).
Tables 4.1 and 4.2 provide data for the ten largest business groups in Mexico for 2008 and 2015, respectively. The list was compiled using the Expansion ranking for Mexico’s largest firms. This ranking includes public, private, state-owned, and multinational subsidiaries.
Table 4.1 Business groups 2008
Table 4.2 Business groups 2015
It is interesting to note that:
- •The relative importance (measured by sales) of business groups within the largest firms is exactly the same in 2008 and in 2015: 42 percent.
- •Walmex—Wal-Mart’s Mexican subsidiary—is #3 in 2008 and #2 in 2015. Wal-Mart entered Mexico through the acquisition of CIFRA, which was a family-owned public firm in 1997.
- •Carlo’s Slim group—Carso—occupies the first place in both periods, although its relative importance decreased from 37 percent of total business group sales to 33 percent.
- •Alfa and Femsa, which represent the Monterrey cluster of firms, account for 22 percent and 26 percent of business group sales, respectively.
- •The sample is pretty stable. No newcomers, no departures.
- •There is not a single firm in the business group sample that is devoted to a high-technology industry.
- •40 and 30 percent of business groups, respectively (2008 and 2015), have a financial unit in their group.
A Summary of Recent Studies on Mexico (1998 to 2018)
Ownership of Mexican firms is characterized by predominant family participation and by a high concentration of ownership and control. To retain ownership control, owners issue shares without voting rights and develop pyramidal structures. By doing this, owners can gain access to capital without capital dispersion. González and García-Meca (2014) examine the relationship between internal corporate governance mechanisms and earnings management within a sample of public firms in Argentina, Brazil, Chile, and Mexico from 2006 to 2009. They find that ownership concentration can decrease earnings management when the proportion of shares held by major shareholders is below 35 percent. Also, larger boards increase the possibility of earnings management probably due to the decrease of monitoring of TMTs as a result of inefficient coordination and communication. Furthermore, they recommend that firms abstain from hiring “gray” directors (those that maintain some kind of family or professional relationship—current or past—with the firm or its owners) and increase director’s rotation by placing limits on their terms. They cite as evidence the fact that only 12 percent of firms in their sample have time limits for external directors. Thus, with time, directors can become “labels” where independence is not an attitude but only an appearance. Finally, these authors find that when a country improves the quality of its formal institutions, a decrease in earnings management also takes place.
Machuga and Teitel (2009) use a nonfinancial sample of 34 Mexican public firms from 1998 to 2002 and find that firms that do not have concentrated family ownership or share directors have greater increases in earnings quality. These authors create a new definition of board independence that excludes family relationships, and when introduced in their sample, they find that 24/34 firms do not comply with the required 25 percent of independence at the board level. They also find a significant overlap across boards of firms with concentrated family ownership. These executives might meet the definition of independence, but the interlocking nature of their boards could probably not be known as “impartial.”
Castro et al. (2009) compared public firms from Brazil, Chile, and Mexico in 2001 to 2002 and found that CEOs of Mexican firms stayed on the job for twice as long as the average of their counterparts (12.8 vs. 5.4). CEOs in Mexico also own much larger portions of their firms (17.5 vs. 1.5 percent average). Mexico also has a much larger portion of firms with dual share structure (48 percent vs. 14 in Brazil and 7 in Chile). Furthermore, Mexico has the largest number of firms where CEOs are also board chairpersons—a practice that is forbidden by law in Chile and England. Finally, the size of Mexican boards is larger; 11.7 versus 9 for Brazil and 8 members for Chile.
Chong, Guillen and Lopez de Silanes (2009) find that better firm-level corporate governance practices are linked to higher valuations, greater performance, and more dividends. They argue that it is only through the development of efficient institutions and investor protection that firms can secure sustainable long-run access to finance. These authors use the compliance scores from the Mexican code of good governance to assess if there is a performance outcome from the code prescriptions. They find that the average company in Mexico met 78 percent of all recommendations in the code with a minimum score of 30 percent and a maximum of 98 percent. They additionally show how dispersed ownership is a myth; in a typical top 10 global firm, 45 percent of the shares are held by the largest three shareholders. Additionally, the countries with weak investor protection have larger share ownership concentration: Latin American countries have larger ownership concentration than the world average. After Greece and Colombia (68 percent), Mexico has the third-largest ownership concentration in their 45-country sample (67 percent). The percentage of firms from Mexico that are listed in the United States is among the highest in the world (15 percent). Thus, in an environment of weak investor protection, firms try to find ways to access external capital markets.
San Martin-Reyna and Duran-Encalada (2012) contend that families in Mexico play a crucial role in defining corporate governance practices. These authors look at board composition in Mexican public firms from 2005 to 2009 and find that only 20 percent of their sampled firms had a majority of outside directors (although these outsiders could also be sitting in another firm within the same business group); 35 percent of board members belong to the chairman’s family, and in total, 57 percent are either family or firm insiders. They provide evidence that shows a substitution effect: firms without ownership concentration tend to have more independent board members and higher debt levels. This leads to better financial performance for nonfamily firms. For family firms, both higher debt and more independence lead to negative results. Thus, they conclude, ownership concentration is used as a control device.